Retail investors can now buy into the credit long/short fund of Europe’s largest hedge fund for as little as $10 a share.
DWIM believes matching its investments’ liquidity with its withdrawal terms is important “because investors have the right to get their money out when they want,” but that it also forms a healthy trading philosophy which “makes you trade better and focus on total returns”.
Kawkabani says: “You can express views on the credit markets through spreads contracting or widening, through yields rising or falling, or through index tranches or ABS, where you have a slew of different risks from pre-payment risks to recovery risks to correlation risks. There are so many ways to express views on the markets in trades with asymmetric risks.
“The credit market is large and there is not enough capital available. We therefore believe the opportunity set within credit markets for a trading strategy is significant.”
Charlotte Valeur Adu, chair of Brevan’s Credit Catalysts investment trust, says: “There are only a few credit managers who can perform in rising and in falling markets. I am comfortable David Warren is one of them.”
Typical of hedge fund managers, the New York team seeks trades with asymmetric pay-offs. These are ones that could lose a little if things go wrong, but if they go right the pay-off could be significant.
Examples of this have been MBS related to Ambac, Tronox and, in January, US-based containerboard maker Smurfit-Stone Container Corporation. BHCC bought into SSCC’s bankrupt, non-performing debt during 2009 from as low as 27 cents in the dollar.
The expected catalysts of SSCC receiving US government tax credits, as well as SSCC’s emergence from bankruptcy and transfer to bondholders’ hands, all occurred by the third quarter of 2010. BHCC’s position in its bonds, which had converted to equity, generated about one third of the total 1.79% gains for the fund’s US dollar class in January, despite being less than 2% of fund net asset value.
The bonds had fallen 15% at one stage during BHCC’s holding period, but then doubled in value – “the kinds of trades DWIM loves,” according to one investor.
DWIM also keeps intense focus on risk controls to preserve capital, through a high degree of diversification across credit strategies and risks, and by applying stop losses to individual trades and also at trader and fund level. It uses Brevan Howard’s infrastructure and risk management, which co-founder Alan Howard spent two years building up before even starting to invest.
Risk managers at Brevan are independent of its investment managers and are renowned for unrelentingly strict oversight, down to the level of individual traders – senior managers not excepted.
“Not even Alan Howard is exempt from a grilling by the risk committee should he go wrong,” noted one investor.
DWIM also has a sharp focus on detailed research. When it comes to MBS, for example, the team analyses likely default rates under different scenarios, and picks through securities. It uses a loan database to view monthly aggregated performance characteristics of loans, analyses estimates of the prevailing credit capacity of borrowers, and on a macro basis, whether a geographic area exhibits high or low unemployment rates.
One investor says DWIM predicted a more volatile year in 2011, and thus the need to remain agile in trading. “There are a lot of issues out there, including pension and municipal bond issues, so there are a lot of risks in the system. It’s all about putting trades on the right way and getting the right time horizon.”
It is not thought BHCC has any immediate plans to top up its current $168m – by issuing new shares, for example – but that DWIM would be willing, and capable, of taking on more permanent capital via BHCC over time.
The popularity of the strategy is reflected by the fact BHCC shares now trade at a premium to net asset value of about 1.3% – one of few listed hedge funds to have traded at a premium since the crunch.
Kawkabani says having listed funds allows Brevan Howard to diversify its investors, and shareholders of BH Credit include wealth managers, private banks and funds of funds. Valeur Adu says diversifying investors was as much a part of risk management as applying strictures to trading.
To invest in BHAM’s flagship Master fund, an investor typically needs a spare $10m – compared to about £10 or $10 per share in Credit Catalysts.